Definition of Bullish Risk Reversal

What is a "bullish risk reversal" trade in the world of options? What is meant by a bullish risk reversal trade?

In the world of options, a "bullish risk reversal" trade is made when you feel as though a stock has only a limited chance of going down and a very strong chance of making a meaningful move to the upside. This is a trade to be put on when you are strongly bullish on a stock.

The explanation of the term Risk Reversal by Dave Manuel.  In photo: candle chart.

The bullish risk reversal trade consists of two parts:

1) Selling of a put
2) Purchasing of a call

So, let's say that stock XYZ is currently trading at $18. You decide to sell a put at $18 that expires in a month for $1.75, while also buying a call at $18 that expires in a month for $1.65.

The worst case scenario is that XYZ trades lower and you are assigned shares at $18 when the options expire. In this case, your calls would also expire worthless.

The best case scenario is that XYZ trades up substantially, with the calls being worth significantly more than what you paid for them, and the puts expiring worthless.

Let's say that you sold 1 put and bought 1 call.

In one scenario, XYZ is at $15 when the options expire. You would be assigned shares at $18, and you would be down roughly $3/share on your position.

Now, let's say that XYZ has traded up to $25. Your call would now be worth $7, significantly more than the $1.65 that you paid for them. The put that you sold would be worth $0, which means that you would keep all of the premium.

That is a "bullish risk reversal" trade.

-- Articles That Mention Bullish Risk Reversal: